Cheap Drugs from Canada Won’t Reduce U.S. Drug Prices

Presidential candidates Hillary Clinton and Bernie Sanders have both proposed importing cheaper drugs from Canada as part of their solutions to lower drug costs for Americans. The proposal isn’t new: other politicians, including former Republican presidential candidate John McCain, have also endorsed it.

Why import from Canada? The general argument is that prices are cheaper (estimated to be 35% to 55% lower), safety regulations are in place to ensure drugs aren’t tainted or fake, and transportation is easy since it’s located close by.

Currently, importing pharmaceutical drugs from other countries is illegal. However, in certain instances, such as limiting personal imports to less than a 90-day supply, the FDA acknowledges it will look the other way.

“We’ll reduce American pharmaceutical prices by importing cheaper drugs from Canada” is an appealing sound bite. Voters are led to believe the solution is as simple as trucking discounted pills over the border. But the reality is far more complicated. It’s a stretch to believe pharma executives will lean back and in essence say, “Sure, we’re okay with allowing our big profits from the U.S. to dwindle because we’re selling drugs at a discount to Canada.” Drug companies won’t allow such mass importation to occur.

The reason why pharmaceutical prices are relatively high in the U.S. is that drug companies employ a common strategy called differential pricing. This strategy targets specific segments with different prices. So instead of having the same price for everyone, the goal is to tailor the “right” price to various segments. Movie theaters, for instance, use differential pricing by offering lower prices to students and seniors. The assumption is students and seniors are sensitive to price, so offering targeted discounts to them is profitable. As a result, moviegoers seated next to each other often have paid different prices.

For differential pricing to be profitable, targeted segments have to be easily identifiable, and, most importantly, arbitrage cannot occur. By arbitrage, I mean those who receive discounts don’t resell to customers who are currently paying more. This strategy works well at cinemas: it’s easy to identify seniors/students, and since tickets are sold individually at the door, enterprising seniors/students typically aren’t reselling discounted tickets for a profit.

Why are drug prices so much higher in the U.S.? The answer is straightforward: most countries regulate prices or have a single-payer health care system, in which the government pays for citizens’ health care costs. In a single-payer system, the government buys all a country’s pharmaceuticals, and it has leverage in “take it or leave it” negotiations with pharma companies.

In contrast, the U.S. doesn’t regulate drug prices, nor does it have a single-payer system. As a result, each U.S. health-related entity (primarily insurance companies) has to individually negotiate with pharmaceutical companies, which leads to higher prices for two reasons. First, no U.S. health insurance player is big enough to play pricing hardball with drug manufacturers. Just as important, to keep their plans competitive, insurance companies are under pressure to make deals to provide the best medicines to their policy holders. So in contrast to prices being dictated by foreign countries, drug companies have the upper hand in U.S. negotiations. What results is the intended outcome of differential pricing: different countries pay different prices for the same drug, with U.S. citizens paying a hefty premium.

To understand why importing drugs from Canada won’t result in lower prices, let’s return to the cinema. Suppose you own a movie theater and notice groups of students are reselling their discounted tickets in the lobby to customers who normally pay full price. What would you do? Probably discontinue the discounts or impose restrictions to limit the arbitrage. This is exactly how pharmaceutical executives will react if Americans start importing large quantities of drugs from Canada. New restrictions will be attached to discounted Canadian deals. For example, exports will be banned, or quantities sold at a discount will be limited (enough to cover citizens), with amounts over the limit being charged full price. Poof, there goes the grand plan to lower American drug prices.

Policy makers need to realize that importing drugs from Canada will result in the equivalent of a whack-a-mole pricing game. Pharmaceutical companies will quickly and easily amend strategies to close the discount loophole. After all, drug companies are for-profit companies with a mandate from investors to earn the highest profits.

Reforming prescription drug prices is a two-step process. First, understand whether Americans want reform. They may be fine with subsidizing other countries and be uncomfortable with any tradeoffs from reform, such as a potential reduction of R&D. Just as important, Americans need to realize that there is no free-market mechanism that will reduce drug prices, that regulation or single-payer strategies are the only options to do so.

This issue is the real root of the debate, and one Americans can’t simply avoid by taking a detour through Canada.